Throughout the year, we have owned a collection of businesses with solid prospects, led by managers aligned with our long-term interests, trading at reasonable valuations. Reflecting our confidence, our gross long exposure has been consistently in the mid-to-high 90% of gross assets. On the other hand, we have felt less sanguine about the broader market, demonstrated by our short positions against ETFs tracking market indices reaching roughly 30% of net assets as we entered the fourth quarter.
The fourth quarter was painful for investors. Warning signs of a cooling economy were compounded by investors’ perception that the Federal Reserve had mismanaged interest rate policy. Add fear of escalating trade tensions and a view that the new split-controlled Congress might undermine the so-called Trump Bump, and investors’ collective psyche switched from greed to fear in short order. With this backdrop, the Fund’s performance story for the quarter is straightforward. Our longs were caught up in a bruising, market-wide sell- off, while our index shorts provided ballast. The result delivered modest relative outperformance amid an otherwise painful absolute experience. The full accounting of the quarter’s top contributors and detractors can be found in the tables that follow.
We firmly believe that volatility can be our friend, but only if we have the necessary conviction to act when opportunities present themselves. On the long side, our gross exposure grew from 96% to 98% of net assets, but simply describing the Fund as “modestly more invested” is insufficient. Instead, with valuations more attractive across the board, the competition for capital resulted in changes that we believe strengthen the portfolio overall. We continued to build our positions in high-quality businesses like Facebook (FB, Financial), Charles Schwab (SCHW, Financial) and Markel (MKL, Financial). We made new investments in Black Knight (the dominant provider of mortgage servicing software) and bought back Amazon, businesses that we believe are worthy of the title “value compounders.” We also opportunistically added to DXC and Summit Materials, where we believe market prices significantly undervalue what our analysis suggests the businesses are worth today. Offsetting these purchases, we pared back on some more fully valued investments and exited our small position in Liberty Expedia Holdings and lower-conviction holding Tupperware Brands. Our 30% short position entering the quarter was roughly 75% against the S&P 500 and 25% versus the Nasdaq 100. As both indices declined, we continued covering throughout, eventually closing the Nasdaq short entirely. The short book closed the quarter at 17% of net assets.
Turning to the full year, 2018 performance was generally in-line with our benchmarks. Relatively unknown (by the broader market) payments software provider Intelligent Systems was the year’s top performer, as its strong growth has begun attracting investor attention. Better-known payments network Mastercard experienced continued robust growth (and stock price appreciation), and XO Group had a strong first half, landing both companies in the annual honor roll. Our top detractors for the year were Liberty Global, Colfax and Liberty Broadband. Improving trends at Liberty Global’s U.K. business have been offset by challenging competitive environments at their Belgium, Swiss and Dutch operations. We continue to think the stock is undervalued, and materially so if the pending sale of German and Eastern European assets to Vodafone Group is approved and closed this year. Colfax’s stock started falling along with other industrials in October, then took a sharper leg down after the company announced the acquisition of DJO Global, an orthopedic solutions company. At the same time, Colfax announced the planned exit of its cyclical air & gas handling business. Investors had long awaited a platform deal, but they did not expect or care for this much change. We agree there are a lot of moving parts but believe the ultimate result will be a better, more durable business. Finally, we believe Liberty Broadband (owner of a 21% stake in Charter Communications) is poised for growth as free cash flow growth ramps at Charter after several years of integration and investment spending.
Looking ahead, we don’t know where the bottom might be. We may have already bounced off it, or it may not arrive for months. What we do know is that we feel very good about the businesses we own, and at current valuations, the starting conditions are ripe for good long-term shareholder returns. As always, we appreciate your confidence and the opportunity to invest alongside you.
